Stock Market Bubble: Key Factors and Historical Examples

A stock market bubble refers to a scenario where the prices of shares are pushed to levels that are incredibly high and above the market value of the company due to unbearable price hike. Any bubble of this nature leads to its burst, which results in a sharp drop and causes immense financial losses particularly to the speculative investors who contributed to the creation of the bubble.

In that regard, understanding how such bubbles work and their effects would form a crucial stone of importance for investors while making decisions in volatile markets. For this purpose, this article will discuss the concept of what is a stock market bubble, its historical examples, India stock market bubble and how it is relevant to the Indian stock market.

What is a Stock Market Bubble?

A stock market bubble is when the stock price goes too high because of speculation rather than showing any sense of the fundamentals of that particular company. The more investors come into action for quick profits, the more prices tend to inflate. Inflation tends to call for that, and then it gets dangerous because a correction in the market is bound to happen.

Some of the common signs of a stock market bubble are:

1. Excessive Speculation: The basic idea of investing in stocks is that they begin to buy stocks with the expectation of an increase in the price of the stock rather than in the performance of the firm.

2. Price Inflation: The stock prices go way above the real value of the stocks.

3. Investor Euphoria: When the bubble forms investors can be enthusiastically bullish about their pricing saying they will never go down.

4.Collusion: In this stage, the prices are seen collapsing sharply with reality putting in that causes panicking with huge losses.

History of Stock Market Bubbles

To better understand a stock market bubble, looking at its historical happenings will help gain better insight for it. These events have served very well as examples of how bubbles work and how their collapse leads to chaos.

The Tulip Mania (1630s)

Tulip Mania in the Netherlands was the first recorded case of a bubble. Tulip bulbs had reached such incredible prices because of the fever of speculation at that time. Bulbs were sold and purchased at rising prices without considering the price value of the actual tulip. The prices came crashing down in 1637, badly burning investors.

The South Sea Bubble (1720)

Another excellent example of a stock market bubble is the South Sea Bubble. The South Sea Company convinced investors in Britain that they could make fabulous profits trading with South America. Fuelled by speculative optimism, the stocks rose to the sky only to plummet as the ‘assumptive’ bases for all the firm’s promises were fake. Unfortunately, that company went bust in financial turmoil later that year.

The Dot-com Bubble (1995-2000)

The dot-com bubble was a situation where companies’ values were rapidly inflated as they operated based on the Internet. Investors speculated that the Internet would revolutionise business, which was enough for the high stock price of many technology companies, even though many had little or no profit. When the bubble finally burst in 2000, many tech companies went bankrupt, and stock markets worldwide plummeted.

The 2008 Global Financial Crisis

The early 2000s U.S. housing bubble was critical in the manifestation of the global financial crisis of 2008. The reason is that easy credit channeled speculative investment into housing, causing a marked inflation of its price. The result was a global recession as soon as the housing price bubble burst.

Historical examples clearly show how the stock market bubble came to be and how lonely the situation became afterward.

Identifying a Stock Market Bubble

Identifying a stock market bubble can be challenging. However, sure signs may help investors recognize when one is forming:

• Price-to-Earnings (P/E) Ratios: If the P/E ratios of stocks or the market itself are higher than historical norms, that may indicate that prices are relatively high.
• Media Hype: When the media’s focus on the stock market is so high, and stories of easy money are plentiful, investor fever dominates.
• Sharp price movements: Equities experiencing a sharp spurt within a short period without any material increase in the underlying fundamentals may suggest speculative mania.
• Irrational Exuberance: When individuals purchase stocks based solely on momentum or FOMO without critically studying a company’s financials, it becomes a bubble.

Awareness of such signs could prevent some investors from participating in the speculative frenzy, saving their investments when the bubble bursts.

India Stock Market Bubble

A global market bubble involves stock fluctuations, though not only global markets experience bubbles; India has had its share of its Indian stock market bubbles, which show the same pattern: speculative behaviour, overvaluation, and subsequent collapse.

Harshad Mehta Scam 1992

One of the worst India stock market bubble cases probably occurred in the early 1990s in the Harshad Mehta scam. Harshad Mehta, a stockbroker, manipulated the prices of stocks using fraudulent means and created an artificial Sensex rise. His bubble burst when he was fully exposed for his illegal activities, which crashed the stock market. It led to a steep decline; the Indian market needed drastic change after this incident to be on the growth path.

Boom and Bust in Tech (The 2000s)

The Indian market witnessed very steep prices rising particularly in the technology stocks mirroring the world’s dot-com boom. The high-tech companies have been over-valued based on growth rates that are similar to that of the United States.When the global dot-com bubble burst, the Indian market declined sharply, and the brunt was borne primarily by tech stocks.

Causes of Stock Market Bubble

Understanding what causes a stock market bubble gives an individual plenty of time to avoid unnecessary loss. There are several fundamental causes for this:

1. Speculation

Another factor behind the stock market bubble is speculative trading. Due to an anticipation that the prices would continue rising, investors came in and began buying stocks entirely, irrespective of the company’s performance. When more investors are attracted to this proposition, the price rises, creating a self-fulfilling cycle that eventually bursts like every other bubble.

2. Economic Condition

The least interest rate, and easier credit access even gave the wind to the stock market bubbles. Low-interest rates make investors gamble more in overpriced securities expecting higher returns.

3. Psychological Aspects

Another key component that contributes to the formation of bubbles is human behavior. Herding in a rising market bubble is the notion that investors are purchasing stocks because they believe everyone else is. FOMO’s fear of missing out can as well lead to greater and irrational investments which fuel the bubble further.

4. Technological Innovation

A technological advancement may cause an expectation about future profits, boosting the value of the stocks. The dot-com is one of the examples of how investors can come to the decision that new technology is more profitable and overpay for the shares.

Current scenario of India Stock Market Bubble

The Indian stock market has been resilient for many decades and has not remained free from bubbles. Analysts always look for indications of an Indian stock market bubble, as speculative behaviour and rising valuations in specific sectors scare many people. Investors need to be watchful so they do not get carried away by speculative trends without proper research in the Indian market.

Conclusion

Understanding what the term “stock market bubble” refers to and what it would imply means pretty much everything to investors navigating financial markets responsibly. No doubt, the history of stock market bubbles is replete with examples of stock market bubbles leading to heavy economic losses when they burst, often exposing investors to unpleasantness unprepared for, which is no exception.

Examples of similar historical mishaps include the Harshad Mehta scam; there are several other contemporary Indian bull runs in addition to speculative trends. Therefore if anyone wishes to invest individually and are really confused due to fluctuating market conditions, SMC Global Securities has offered organised services to suit the individual investors. It can be helpful for investors from getting trapped in the next bubble of the Indian stock market.

FAQs on Stock Market bubbles

1. What is a stock market bubble?

A stock market bubble is the occurrence of a situation in which there is a drastic increase in the price of stocks to levels that are considered extreme and unrealistic. It is caused by the activities of ‘herd’ buyers with the intention of making quick profits and is followed by terrible crashes which cause a great loss of money.

2. How do stock market bubbles occur?

Primarily, the creation of a stock market bubble can be represented as a superposition of these factors: over-valuation, high costs, bullish shareholders, and cyclic nature. These might lead to speculation due to low interest rates and psychological factors.

3. What signs show that a stock market is a bubble?

Here are some signs of a stock market bubble:

• Price-to-Earnings Ratios
• Media Hype
• Rapid Price Gains
• Irrational Exuberance

4. What is the impact of the stock market bubble in the economy?

The stock market bubble burst, and caused extreme losses due to the price cut. It affects the economy, and its instability reaches far and wide.

5. How do investors and other stakeholders protect themselves against stock market bubbles?

Investors must protect themselves against stock market bubbles, research adequately, Diversify not follow the crowd, Be patient.

Author: All Content is verified by SMC Global Securities.